HC 742 Electricity Market Reform

Carbon Capture and Storage Association

Response to the Energy & Climate Change Select Committee Inquiry:

Electricity Market Reform

Introduction

1. The Carbon Capture and Storage Association welcomes this opportunity to respond to the Committee’s inquiry into Electricity Market Reform (EMR).

2. The CCSA brings together a wide range of specialist companies across the spectrum of CCS technology, as well as a variety of support services to the energy sector. The Association exists to represent the interests of its members in promoting the business of CCS and to assist policy developments in the UK and the EU towards a long term regulatory framework for CCS, as a means of abating carbon dioxide emissions. In the power sector.

3. The CCSA notes that meanwhile DECC have now launched a consultation on EMR and welcomes it. The CCSA intends to respond in detail to the consultation. This paper presents higher level statements of principle in advance of detailed comment on the proposals.

Background

4. The CCSA recognises the challenges that are faced in the UK in respect of investment in the power sector. There will need to be a massive inflow of capital to provide low carbon power generation and to guarantee continuity of supplies. EMR must, as a matter of urgency, provide a robust and reliable market with adequate returns to ensure that generators have long term confidence in their investment.

5. The CCSA recognises the myriad of different financial mechanisms currently in place for different low-carbon technologies and the need for EMR to streamline this. However we strongly urge consideration that a "one-size-fits-all" approach will not be applicable to all technologies, particularly in the short-term. The Government is committed to supporting a mix of energy sources to enhance UK energy sector resilience. To ensure the appropriate mix of technologies can be built in the required timescale to meet climate change targets, it will be necessary to retain some specific financial mechanisms for certain technologies for a period. The proposed DECC policy recognises this through ‘grandfathering’ arrangements.

6. The CCSA has welcomed the publication of the Government’s Climate Change Committee’s (CCC) report ‘The Fourth Carbon Budget’ and fully supports its conclusions. In particular that the average emissions intensity of the power sector should be reduced from its current level of around 500gCO2/kWh to 50 gCO2/kWh by 2030 – in line with the existing recommendation from the CCC that the power sector should be nearly decarbonised by 2030. The CCSA also notes that the Committee expects 30-40 GW of low carbon plant to be built during the 2020s and suggests that the required capacity is likely to be at least at the top of this range taking account of other CCC recommendations regarding electric vehicles and electric heating.

7. The CCSA recognises that a wide range of low-carbon power generation technologies will need to be employed to achieve the decarbonisation objective above and wider climate change targets. In particular, the EMR should be designed such that investment conditions are favourable in all technologies.

8. To the extent that there will be evidence from other associations representing nuclear and renewable power the CCSA is de-facto representing fossil power generation with CCS. The CCSA does not take a position on the type of fossil fuel used to generate power and recognises the need to capture CO2 from gas as well as coal fired plant. Furthermore, the role of biomass co-firing with CCS as a means of carbon-negative generation offers an opportunity which should also be incentivised.

9. The CCSA understands the need to reform the electricity market at this time, however we would stress the need to minimise the transition period between the current structure and the EMR as this has the potential to cause significant uncertainty for investors with potentially severe consequences in delaying investment in new electricity generation.

Carbon Capture & Storage- early stage demonstration

10. Carbon capture & storage is developing rapidly. Some commercial scale technologies for capture exist and there are already a few commercial scale CCS projects. However for many technologies and for power generation in particular the industry is in the demonstration phase in the UK and elsewhere in the world. There are many difficult issues of policy and of integration along the full capture, transport and storage chain that remain to be solved. In consequence, the capital and the operating costs of the early plants will be greater than when CCS technology is more mature with widespread commercial deployment (as with all new low-carbon technologies).

11. For early stage CCS projects it is accepted that there needs to be a special incentive regime that reflects these first-of-a-kind costs and uncertainties. The first-of-a-kind costs broadly fit into two categories. Firstly, sub-optimal technical design and the commercial risk profile associated with interdependencies along the complete CCS chain may require recognition in initial projects. Secondly, the first projects must bear the full costs associated with the establishment of a CO2 transportation and storage infrastructure. Subsequent projects will be able to use the transport and storage infrastructure put in place as part of the early projects and hence will have considerably lower costs. Careful consideration is needed in the selection of the first tranche of projects to ensure maximum benefit is achieved in terms of promoting follow on projects

12. The initial projects will require a special funding mechanism although it is important to note that early stage CCS demonstration plants will be operational during the lifetime of the reformed electricity market, in power plants that will be governed by it. CCS is expected to be a cost effective contributor to the low carbon energy mix, requiring less support than most renewable energy technologies.

13. The UK Government commitment to fund four CCS demonstration projects and the EC, NER300 commitment to provide up to 50% funding for possibly 8 CCS projects are crucial to enable the testing and introduction of near term commercial CCS technologies. The arrangements introduced under the EMR must be tested against their ability to underpin the continued operation of the demonstration projects beyond the demonstration support period and to enable investment in further CCS projects.

Affordability through competitive markets

14. Design of the reformed electricity market must effectively address the three cornerstones of affordability, security of supply and environmental integrity (essentially climate mitigation through carbon abatement).

15. In terms of affordability an essential feature of the market should be competition in relation to whatever market mechanisms are adopted. The market should be constructed so as to avoid any cross subsidies and to seek out best value for money for the consumer in the provision of the principle products, electrical supply and electrical energy. It is noted that this can be achieved by competition between tranches of generation if Government chooses to influence the market to provide a generation technology mix which meets the overarching requirement of affordability security of supply and environmental integrity. It is noted that the proposals aim to ensure that competition will remain a market driver.

Supply security through payment by available capacity

16. Security of supply means ‘keeping the lights on’ in both the short and long term. Over-dependence on any one technology can be managed should Government wish to, rather than being left to the market alone. There is a strong case that such intervention is justified to ensure that new capacity is built in a timely manner and over-dependence on any one fuel or technology is avoided

Should Government aspirations of a very large tranche of wind generation be achieved then this will require an equally large tranche of flexible plant to manage the associated intermittency. It is to be expected that this standby plant will need to receive capacity payments in order for the investment to be justified as no capital intensive plant with CCS would otherwise be built to meet this need.

17. Hence a system of payment by available capacity will need to be incorporated into the reformed market. The emphasis here will be on availability, not just capacity. Power plants that operate with sufficient flexibility should be paid a premium for providing this back-up service. There needs to be an established measure of quantity and time of response to demand and some measure by which availability can be verified in order to qualify the plant for payment. Payment should be time related and this may be broken down into relatively small intervals but the contract to provide available capacity should have long term, say 15 years to provide a solid basis for investment.

18. The above argument is aimed at ‘mid-merit’ plant that will be expected to operate for a substantial proportion of their time. For peaking plant, in the absence of sufficient pumped storage or other storage technologies, there does appear to be a case for open-cycle gas turbines to provide short term back-up. A similar logic applies but a special exemption could be made on carbon intensiveness reflecting their low total emissions and ensuring value-for-money for consumers.

19. The Government has proposed a targeted capacity mechanism; the detailed operation of this mechanism has yet to be established. Potentially the mechanism could be very appropriate as it will substantially target fossil generation.

20. Assuming the cost of providing the capacity margin will be averaged over the market it will be important, in the presentation of market statistics, to apportion the cost between demand variation and intermittent generation.

Low-carbon generation revenue support

21. At the present time, all power generators are paid a market rate for ‘brown’ electricity no matter what the source. Renewable generators are paid a premium for ‘green’ electricity through the Renewable Obligation and, at a smaller scale, through feed in tariffs. A reformed electricity market should be designed to recompense all generators of low carbon electricity. A market mechanism needs to be established that rewards all generators at a premium rate for this premium product. Ideally, this market mechanism should not distinguish between technologies although it is apparent that existing policies will take time to work out of the system. Departure from this principle should only be considered to obtain the desired mix of technologies to meet security of supply requirements or hasten the achievement of decarbonisation of the complete electricity sector.

22. In the longer term all power (except perhaps for derogation for peak-lopping mentioned above) will be generated with low carbon. CCC, referred to above, recommends that this should be achieved by 2030. At that time the market will therefore be for premium grade electricity (i.e. carbon-free) and there will be no need for a distinction between ‘green’ and ‘brown’. Electricity market reform needs effectively to address the pathway for power generation to become carbon-free. Feed In Tariffs (FIT) applicable to CCS plants as well as renewable generation could achieve this end. This approach reduces the market risk which investors in capital intensive new plant face and hence reduces costs by allowing a lower cost of capital. Mechanisms of this sort have been very effective in a number of European countries in allowing new technologies to be introduced cost effectively into the generation mix. They have the further advantage of attracting a wide range of investors rather than the smaller number who are retail suppliers of electricity.

23. The Government has proposed to introduce a system of FITs with a contract for differences (CfD) against the wholesale electricity price. The CCSA broadly favours the introduction of the FIT although at the time of writing we have not had sufficient time to consider the implications of the CFD especially when the market approaches decarbonisation.

24. The CCSA also welcomes the idea that fossil as well as nuclear and renewable generation would qualify for FIT. We would like to draw attention to the criterion for qualification discussed in paragraph 27.

Carbon Price Floor

25. The CCSA welcomes the proposed introduction of a carbon price floor to bring more certainty to investment in CCS. At the time of writing, there has been insufficient time to establish a view on the required level.

26. The CCSA has long held the view that Government should hypothecate ETS auction revenues back to support demonstration CCS projects. It has been noted that the application of Climate Change Levy to power generation will be a supplementary revenue source arising directly from carbon emissions (effectively a carbon tax on fossil fuel power generation). Government should allocate funds from this source to support an accelerating CCS investment programme and so avoid criticism of itself for drawing on general taxation as well as criticism of the power industry for not paying for its own pollution.

27. Whilst the CCSA does not seek to discriminate on fuel type we would observe that obviously this measure would favour gas over coal and may impact on diversity and therefore security of supply.

Emissions Performance Standard

28. All power plants have a lifetime carbon emission penalty including emissions associated with manufacturing, construction and maintenance. However, fossil fuel power plant, even equipped with carbon capture, will inevitably produce a low level of emissions. For fossil fuel power plants to be treated as effectively emissions free in the context of the new market there will need to be an Emissions Performance Standard (EPS) established. A power plant with verified emissions below the standard would qualify in the market as low-carbon electricity. The standard may be reviewed for new plant coming on stream in future as BATNEEC improves (for example when CCS becomes BAT for fossil fuel power stations). It should be stated that all generators of premium electricity will save on having to buy EU ETS allowances but that fossil generators will rightly continue to purchase EUAs to cover residual emissions.

29. The CCSA understands the need for an EPS being used in the longer term in the above context to qualify electricity for the premium payment. The CCSA is not in favour of an EPS being used in the short term as a form of regulation applied in an effort to force down emissions, particularly in the next critical few years as we demonstrate CCS. This would most likely result in perverse outcomes such as lack of investment or an over-reliance on one specific fuel source. The case against EPS as a regulatory instrument was laid out by the CCSA in its submission to this Committee in September 2010 and is appended to this submission. The proposals for an EPS of 450 or 600 g/kWh are completely unnecessary given appropriate financial incentives and will likely result in no future investment in coal to the detriment of security of supply.

Conclusions

· EMR will be absolutely essential to underpin investment in new power generation capacity.

· Power generators should be rewarded for both providing available low carbon capacity and for kWh of low carbon electricity.

· Capacity payments should be dependent on the ability of the plant to respond to changes in demand. The CCSA broadly agrees with the proposal for a targeted capacity mechanism.

· A premium for kWh of low carbon electricity should be paid. The CCSA supports the proposal for FITs but has yet to reach a conclusion on CfD.

· Low carbon electricity should be defined as below a set level of gCO2/kWh (requiring CCS for fossil fuels)

· This should be the only use of an EPS; CCSA is against the use of EPS as a regulatory instrument.

· The CCSA broadly supports the proposal for a carbon floor price but recommends ring fencing the taxation revenue to support early CCS demonstrations (as an alternative to the CCS levy).

· Whilst the CCSA does not discriminate on fuel type we are concerned that the current Government proposals on EMR will inhibit investment in clean coal and reduce supply security.

The view expressed in this paper cannot be taken to represent the views of all members of the CCSA. However, they do reflect a general consensus within the Association